Question

Tyreek Hill of the Kansas City Chiefs, and his agent are evaluating three contract options. Each option offers a signing bonus and a series of payments over the life of the contract. Hill uses a 10.375 percent rate of return to evaluate the contracts. Given the cash flows for each option, whish one should he choose? Show your work.
Year 0 CF Type Signing Bonus Option A $ 6,000,000.00 Option B $ 5,800,000.00 Option C $ 7,000,000.00 1 Annual Salary $ 650,000.00 $13,000,000.00 $10,800,000.00 2 Annual Salary $ 715,000.00 $13,000,000.00 $11,000,000.00 3 Annual Salary $ 822,250.00 $13,000,000.00 $11,200,000.00 4 Annual Salary $ 975,000.00 $13,000,000.00 $11,400,000.00 5 Annual Salary $20,000,000.00 $11,600,000.00 6 Annual Salary $30,000,000.00

Answer 1

Answer:

He should choose Option B because it has the highest equivalent annual annuity,

Explanation:

To decide which option is better, calculate the equivalent annual annuity using the following formula

Equivalent Annual Annuity = Total Present value / Total Present value Factor

Option A

Where

Total Present value = $37,245,058  

Total Present value Factor = 5.30781306

Placing values in the formula

Equivalent Annual Annuity = $37,245,058  / 5.30781306 = $7,017,025.18

Option B

Where

Total Present value = $46,675,950  

Total Present value Factor = 4.144303839  

Placing values in the formula

Equivalent Annual Annuity = $46,675,950  / 4.144303839 = $11,262,675.64

Option C

Where

Total Present value = $48,905,550  

Total Present value Factor = 4.754748665  

Placing values in the formula

Equivalent Annual Annuity = $48,905,550  / 4.754748665 = $10,285,622.48